by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
randolphp@umkc.edu

RULE AGAINST PERPETUITIES; COMMERCIAL OPTIONS: New York high court applies statutory Rule Against Perpetuities applies to invalidate a commercial option in a sale leaseback deal where option potentially was exercisable beyond the applicable measuring life and beyond the potential life of the lease itself.

Symphony Space, Inc. v. Pergola Properties, Inc., 646 N.Y.S.2d 641 (Ct. App. 1996).

This case has been winding its way through the New York courts for several years, and the Court of Appeal's decision represents the definitive New York position on the Rule Against Perpetuities as applied to commercial options.

Owner of certain commercial property sold its property subject to a non-profit organization and leased back the bulk of portion of the space. The purchase price was consisted mainly of a purchase money mortgage note (for $10,000). The idea was that the buyer would be able to obtain a property tax exemption for the whole building. In exchange the deal permitted the non profit to use its retained portion of the building at no further cost, while the property tax savings were passed on to the transferor/lessor through lower lease payments for the balance of the building.

The seller retained an option to buy the property back for a token amount. The option agreement was an agreement that was separate from the lease transaction. The option could be exercised at identified points in time beginning nine years after the transaction was carried out. Further, the option was triggered by the non-profit optionor's default in the mortgage or in its landlord's obligations under the lease. By its terms, the option was not terminated by a tenant default in the lease. The parties had not anticipated that the Rule would apply to this transaction and the option did not include a "Perpetuities savings clause" and did not otherwise identify any measuring lives.

Years later, after the property had skyrocketed in value, the assignee of the initial option-holder decided to exercise the option. The fee owner/landlord argued that the option was void. New York's highest court held that first, an option agreement for commercial purposes is subject to the Rule Against Perpetuities, notwithstanding the criticism in the literature about subjecting commercial options to the rule against perpetuities. The court distinguished prior authority holding that the Rule does not apply to rights of first refusal.

Second, the court held that the option did not qualify as appurtenant or appendant to the lease and therefore case law regarding appurtenant options (which might take the option out of the purview of the rule against perpetuities) did not apply.

Accordingly, because the parties were corporations and no measuring life was stated in the instruments, the perpetuities period was simply twenty-one years. Because the option was exercisable after the termination of the lease and the twenty-one year period, the option agreement violated the rule against perpetuities.

The court refused the seller/optionee's request to adopt the "wait and see" exception for commercial transactions, ruling simply that the exception was not in the statute.

It appears that the result of the case is that the non-profit obtains property worth millions for a purchase price of $10,010. Some of the property is subject to a lease to what is now a very angry seller/lessee. But when the lease is over the seller is out.

Note: The seller's option probably also operated as a clog on the equity of redemption to the extent the option right was accelerated as a consequence of a default in the purchase money mortgage. But converting an option right to a mortgage foreclosure right is a far cry from voiding it altogether, as was done here.

Comment 1: Competent real estate lawyers and title insurers should have identified the Rule Against Perpetuities issue in this case. That's why we're paid the big bucks, folks!!

Comment 2: Most lawyers agree that it makes some sense to place a limit on the enforceability of "free floating" contingent interests. These types of interests might otherwise result in parties making claims long after the circumstances that led the parties to create the interest have changed completely. In such cases, the "ancient limitations" are inequitable and can lead to extortion. But how to we express the limit?

As in many other cases, real estate law has turned to old, familiar approaches in order to dodge the difficult chore of creating new devices to implement policy concerns. Certainly, there ought to be a better way to set limits on the enforceability of commercial interests than to utilize a common law concept designed for use in cases of family wealth transfer. Perhaps this case will spur the New York bar to sit down and develop such a device.

But the editor hopes that New York, in addressing this issue, doesn't through out both baby and bath water and abolish all controls on late vesting interests. The concept, in the editor's view, is a sound one. The very fact that the parties in this case failed to think about the application of the Rule Against Perpetuities helps to illustrate that parties don't think through all the ramifications of their real estate deals, and can create, often inadvertantly, significant title and use blockages that will burden future development.

Comment 3: The New York Court cites but rejects Jesse Dukemenier's suggestions on addressing these problems in Jesse's famous "River Found at Last" article. Jesse is a DIRT reader and one of the leading modern commentators on the Rule. Perhaps DIRT will provide Jesse a forum to lash back at the New York court. What do you say, Jesse?

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last five years, these Reports annually have been collated, updated, indexed and bound into the Annual Survey of Developments in Real Estate Law, volumes 1-6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Stacy Walter at the ABA. (312) 988 5260 or stacywalter@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are inno sense the publication of the ABA.